General Mills Getting Back To Norm

Maybe the markets are getting a bit more rational when it comes to packaged food companies. With many of these stocks up 20% or more over the past year, the last couple of months has seen the momentum fade a bit. Arguably that's a good thing for stocks like General Mills (NYSE:GIS) where the company's self-improvement efforts are likely to be more of the slow-and-steady variety. Although General Mills is back below fair value and arguably a decent long-term hold, it's not likely to deliver another “Market-plus-10%” sort of performance over the next twelve months.

Decent Growth In Q4, But A Little Lumpiness In The Margins
General Mills closed out its fiscal year reasonably well. Sales rose more than 8% as reported, with organic growth of about 1% on a 2% improvement in volume. It's also worth noting that volume improvement is no longer dependent on price cuts, as effective pricing was up about 1% (a negative forex adjustment accounts for the difference).

Revenue was up 2% in the U.S. retail operation, with international sales up 27% in large part due to acquisitions. Like for like, international sales were up in the mid-single digits. Revenue from the bakery operations was down 2%.

Gross margin was down two and a half points from the year-ago period, and almost two points below the average estimate. As a reminder, General Mills has been shifting more of its marketing spend towards store promotions, and that goes into COGS. Operating income was down 8% as reported, and though the company's operating margin was down about two and a half points, it was more or less in line with expectation – again possibly a byproduct of shifting marketing spending from SG&A to COGS. On a segment basis, operating profits were only down about 2%.

A Strong Marketer, But There's Work To Do
General Mills enjoys a pretty solid reputation on Wall Street for being a very good marketer of its products, and a fairly savvy product innovator as well. Judging by share shifts in the last fiscal year, the company needs to put more of that skill to work.

It pays to be cautious when comparing a company's reported sales to scanner data from companies like Nielsen, as there are always gaps and issues with straight-line comparisons. Even so, it looks like General Mills lost a little share in cereal to Kellogg (NYSE:K) and Post (Nasdaq:POST) for the year, but was doing better in the fourth quarter. Likewise, the company seems to have gained on Kraft (Nasdaq:KRFT) in dry dinners and the yogurt market in general in this last quarter.

That progress in yogurt in particular is welcome, as that has been a major talking point for investors. The category as a whole still seems to be having some issues (down about 5% industry wide over the last three months), but it seems like things have gotten meaningfully better from a point three quarters ago when a Credit Suisse analyst declared General Mills' yogurt business to be “in crisis”.

It may be that the company is going into fiscal 2014 with some momentum. General Mills' share position seems better exiting the fourth quarter, and input cost inflation should be pretty moderate for the next year – arguably allowing the company to improve utilization and avoid meaningful price increases.

The Bottom Line
It's also worth mentioning that General Mills continues to grow its international operations, with operations like Brazil's Yoki showing good results and solid long-term expansion potential. I also think it's not inconceivable that General Mills could attract a bidder – there have been rumors and speculation for years that Nestle (Nasdaq:NSRGY) could be interested (they have a large international cereal joint venture), and rumors are picking up that Nestle will sell its stake in L'Oreal before too long.

Leaving aside the rumors, the sideways-to-down action in these shares since the last quarter has put them back into undervalued territory. With just 3% to 4% long-term growth in sales and free cash flow, a fair value around $50 is not hard to generate. That doesn't speak to huge capital gains potential, but then that's rarely the expectation for a solid, predictable, dividend-paying consumer goods company like General Mills.